Wednesday, September 30, 2009

Family Dollar Stores (NYSE:FDO): Morgan Stanley positive ahead of results

Morgan Stanley issuing positive comments ahead of Family Dollar Stores (NYSE:FDO) quarterly results next week:

Investment conclusion: We believe Family Dollar will issue reassuring guidance next week, contrary to market concerns, and therefore think the risk/reward is positive headed into earnings. FDO is down 16% in the past month and currently trading at 11.7x our F2010 estimates, close to a trough multiple. We believe once guidance is given and the air is cleared, the stock could see a relief rally.

What the Market is Nervous About:
• Next year’s comp guidance given the most recent quarter comped a 1%
• Inventory levels given the weaker comp
• FDO’s ability to improve margins as overlaps of improved distribution costs, sourcing costs, and markdowns get more difficult
• EPS guidance given sales and margin outlook
• Execution risk in space re-allocation and product assortment initiatives
• New initiatives that may take up SG&A spend
• Benefits of lower gas prices ending in 1Q which could impact lower income spending

Our Take: We believe Family Dollar’s guidance will be reassuring and management could guide to 1%-3% (or even 2%-4%) comps and EPS of $2.10 to $2.30. We also believe management could state that September sales improved from August and explain part of the weaker 4Q comp due to store re-models. As part of those re-models, SG&A was pulled forward into F2009 and should moderate SG&A growth in F2010 to ~2.5%. Furthermore, we believe there will be commentary on a renewed focus on store level profitability.

Firm is also issuing Research Tactical Idea long on FDO:

We believe the share price will rise in absolute terms over the next 15 days. This is because the stock has traded off recently, making short term valuation much more compelling. We believe Family Dollar will issue reassuring guidance when the company reports on Wednesday, October 7th. Investors are concerned that EPS guidance will be well below street estimates, while we believe the company's guidance can encompass street estimates. Furthermore, we believe the call could give other positive data points such as improved September sales and a renewed focus on store level profitability. The stock has underperformed the S&P by 22% over the past month and is currently trading at 11.7x our F2010 estimates. We believe the earnings call will help clear the air and spark a relief rally in FDO shares.

We estimate that there is about a 70% to 80% or "very likely" probability for the scenario.

Action: FDO has sold off recently after comps / preannouncement on Sept 3rd. Morgan Stanley is listing all the concerns above and they do a good job refuting all of these. Given their conviction I would expect the market to listen and send the stock higher today - $27 is very possible.

1 comment:

  1. I still believe it could go to $27 today if the market cooperates a bit.